This week the United States economy reported an additional 4+ million people filing for unemployment. The cost of COVID19 lockdowns and their destabilizing effect in business is an economic wave unlike anything in our lifetimes. This extraordinary investment environment has also provided tremendous qualitative indication and information about the market’s current assessment of Bitcoin and cryptocurrencies in general.
At Vellum Capital, we want to share the most important observations we’ve studied over the past three months:
1: Crypto markets were a leading indicator during the pandemic
In late February 2020, equity markets started selling for what then looked like the early start of a possible viral pandemic. For investors, Coronavirus is less complex than the opaque financial crisis of 2008. When thinking how this may play out, Coronavirus is a single narrative problem meaning the problem is the virus, and if the virus were to go away, so would the primary origin of the market crash. As the days went by, it became more apparent to investors how an extended business interruption could severely damage whole industries, including travel, hospitality, education.
During this time, crypto markets followed alongside equity markets (including more mature assets such as Bitcoin) as crypto markets also broadly sold to significantly lower prices. In fact, during weekends, when equity and futures markets were closed, one could look to the crypto market, which trades 24 hours a day, seven days a week, as a leading indicator ahead of Monday’s market action. On at least two occasions, Sunday night index futures were limit down, and crypto (without these same exchange restrictions) continued to serve investors by effectively pricing risk prior to the trading week.
2: At this early stage, crypto is a ‘risk on’ asset
Many people have asked if cryptocurrency is then always a forward indicator to equity markets. Generally, no, its recent leading relationship with equities has not historically proven to be statistically reliable in a way meaningful to investors. Crypto and blockchain, however, represent a more complete market than the old centralized exchange system, and this allows crypto to price real-time news more efficiently.
Additionally, because in times of stress, crypto and equities tended to move in the same direction, we can surmise the general global view of crypto to be 1) it is still a “risk on” asset, meaning people tend to be more bullish for crypto when they are generally optimistic about the economy and 2) crypto has the potential to be a primary source for global liquidity.
3: We are still early in the cryptocurrency adoption cycle
Crypto as a risk asset speaks to the economic maturity of cryptocurrencies and really all blockchain derived digital assets. We have for a long time believed the adoption cycle of these assets to have various stages; something along the lines of:
- Specialized Adoption
- General Adoption
- Economic Stability
- Currency Replacement
That crypto sold alongside other speculative assets indicates crypto is still somewhere between stages 1 and 2. Had crypto gone up while the world was melting down, it would argue a maturity between stages 3 and 4. For reference, gold is probably somewhere between stage 2 and 3, because in exchange form (bars not jewelry) it is still held by a small minority of the population, and gold once again (as with the last several economic crises) has failed to be immune to equity dislocations or counter price risks present from more speculative assets.
This is not all bad. It’s actually a very optimistic outlook. Crypto at these early stages has already captured billions and billions in global value. This and the degree to which blockchain technology has already animated major industry is an excellent proposal for crypto’s long term success.
4: Cryptocurrency could play an important role as a global source for investment liquidity
Cryptocurrency has the potential for huge market capitalizations and matched with blockchain’s inherent market transparency, crypto could easily become an excellent source of liquidity for cross-market trading. One problem quantitative finance has faced over the past several crises is the dreaded ‘liquidy hole’. This happens when an illiquid financial product is born into existence in anticipation of offsetting risk upon some highly liquid vehicle. As a simple example, a market maker trading S&P 500 options may use the highly liquid S&P futures to offset directional risk. If the market becomes dependent on known sources of volatility and these sources are interrupted, such an event could be the beginning of global contagion.
5: Crypto is a liquidity pool for investors and while simultaneously supporting consumer needs
Having a pool of globally available assets with a market of capitalization exceeding trillions could provide an excellent offset to the riskiest part of our economy – highly financialized (aka leveraged) investment vehicles. This could also happen within the same distributed network that billions of consumers use for daily transactions – ensuring liquidity for both sides. Why bring all this up now? Because we just witnessed a major economic deleveraging event and while in our darkest hour nearly every traditional financial house required or in some way benefited from publicly-funded assistance, cryptocurrency markets continued their role unabated, unassisted, and importantly without any public cost.
6: Crypto markets are gaining stability as the infrastructure ecosystem matures
This concept about liquidity is exciting because it speaks to an important point, which is the overall stability of the blockchain technology and the cryptocurrency ecosystem. Stability is a minimum viable requirement for cryptocurrency to move out of speculation toward adoption. Exchange hacking and early technology challenges of digital assets created a public narrative of risk and unmitigated loss. The reality is most of these losses were 3rd party provider technology events, not failures of the blockchain or specifically the cryptocurrency technology stack. Throughout the March 2020 market meltdown, many markets including institutional loans, bank repo, and CLO (those most opaque to the public) required interventions in order to maintain liquidity and accountable trading partners. Cryptocurrencies – a completely deregulated and distributed global market – was entirely stable and required no external support. Transactions continued to post to the blockchain, buyers and sellers were matched with more than sufficient liquidity, and throughout all of this cost to society no different than at any other time in history.
Positive fundamentals point to higher pricing
Of all these concepts, most investors will immediately benefit from understanding the investment community perception of digital assets – a ‘risk on’ and speculative trade. Referring back to our adoption cycle, this is good news. It screams ‘early stage’ and makes realistically possible even many of the more outlandish sounding prognostications for Bitcoin’s future. Additionally, we want the price of these assets to move, and move they shall, assuredly in both directions. So long as there continues to be evidence of cryptos growth to greater adoption the fundamentals of this market are overwhelmingly positive for higher pricing.